Danish banks can use contingent convertible bonds as long
as they convert before capital levels breach core Tier 1 equity
thresholds or in the event individual solvency requirements
aren’t met, said Anders Balling, head of the Financial
Supervisory Authority’s banking analysis division in Copenhagen.

“The crucial thing is that they absorb losses while the
bank is still alive,” Balling said in an interview yesterday.
“It’s a condition for the whole framework that the capital is
loss absorbing, otherwise, the bank couldn’t dig into it and go
below their individual solvency requirement.”

The regulator is trying to take a tougher line on banks to
avoid another credit-driven property bubble without squashing
Denmark’s economic recovery. Bond investors have demanded a
premium from Danish banks since the Nordic country in 2011
became the first in Europe to enforce a resolution framework
that pushed losses onto senior creditors.

It costs about 48 basis points more to insure against
default on senior unsecured notes issued by Danske Bank A/S than
it does on similar notes sold by Nordea Bank AB, based in
Stockholm.

Exotic Funding

Denmark is exploring the option of allowing more exotic
funding vehicles to help banks build their capital buffers as
the government commits to its goal of protecting taxpayers from
bailouts. Even banks deemed too big to fail won’t get state
support, Benny Engelbrecht, head of parliament’s business
committee overseeing banks, said this week. Instead, the onus
will be on systemically important financial institutions to
increase their capital reserves, he said.

“It’s of principle importance to this government to
protect taxpayers,” Engelbrecht said.

‘Rough Ride’

“In Denmark, bank debt has had a rough ride because of the
bank failures,” said Per Jensen, vice president of debt
origination at Danske, the country’s largest lender. “You don’t
have to go past last year’s failure of Toender Bank, which had
issued some instruments just a few months prior.”

Toender Bank A/S, a regional bank near the German border,
declared bankruptcy on Nov. 2 after an FSA inspection revealed
impairments big enough to wipe out its equity. Ulrik Noedgaard,
the FSA’s director general, defended his agency’s handling of
the bank and said at the time its management was guilty of
“massive misrepresentation.”

Since Denmark’s property bubble burst in 2008, the nation’s
bank resolution agency has taken over a dozen lenders while the
industry has absorbed another dozen.

The FSA won parliamentary approval last month to give banks
that fall below their individual solvency requirements more time
to recapitalize. The compromise was struck after the agency
tightened its rules.

Sifi Panel

A lawmaker-appointed panel is due to present its
recommendations on Denmark’s systemically important banks by
March. The proposals will include a list of which banks should
be deemed too big to fail and how much extra capital they must
hold. It will also address the need for living wills that would
work as roadmaps for orderly resolution.

Danish banks already face new requirements to hold as much
as 18 percent of risk-weighted assets, including capital
conservation and countercyclical buffers, according to the FSA.
Soeren Holm, the chief financial officer at Europe’s biggest
issuer of covered bonds backed by mortgages, Nykredit A/S, said
this month he expects Sifi banks to be required to hold as much
as 3 percentage points in additional capital.

Nykredit, which isn’t listed, is looking into issuing debt
instruments that mimic the characteristics of CoCos, Chief
Executive Officer Peter Engberg Jensen said in November.

“We think CoCos can fulfill our aim of having loss-absorbing capital if designed the right way,” Balling at the
FSA said.

Banks are struggling to build equity amid higher writedowns
and a negative central bank deposit rate, and have improved
capital ratios in part by limiting growth in lending, putting an
economic recovery at risk. Gross domestic product shrank 0.4
percent last year, according to government estimates.

Impairments Rise

Industry-wide impairments climbed 51 percent in the six
months through June compared with the same period a year
earlier, the FSA said in a December industry analysis. The jump
followed the FSA’s tightening of write-down procedures. Lending
grew by 0.3 percent to 1.89 trillion kroner ($338 billion),
while banks raised core capital levels to an average of 14.99
percent from 14.61 percent in the same period a year earlier.

“The Danish krone market is starved for high-yield
opportunities” so “the underlying dynamics are in place for
good demand should new bank debt offerings come to market,” he
said. Success will depend on who’s offering, he said.

The instruments are similar in some ways to debt that banks
already issue, with the main difference being “the trigger in
the future might be set at a higher level, enabling the bank to
survive the trigger event,” according to Torben Jensen, chief
dealer at debt capital markets at Copenhagen-based Nykredit A/S.

While pricing probably will be difficult, “I don’t see why
investors would not buy them,” he said.